Pensions Vs ISAs: Which Is Best For UK Investors?

Most UK investors save at least in part for their retirement years, with nearly 80% of employees participating in workplace pension funds and many more investing in personal pensions. But with the attractive benefits and flexibility of Individual Savings Accounts (ISAs), are pensions always the best option?

We have evaluated different retirement saving options to help UK investors choose whether a pension, ISA or a mixture of the two is best for them.

Interactive Investor leads the pack with its flexible ISAs and SIPPs. The FCA-regulated firm offers a terrific platform and app, low fees and a smooth sign-up.

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The information provided on this site is solely for informational purposes and should not be considered financial advice. Before making any investment decisions, seek personalized advice from appropriate professionals.

Understanding Your Options

For most people in the UK, the choice for retirement savings is between a pension and an ISA. Each of these has benefits and drawbacks, but there are also multiple options when choosing a pension or ISA which we explain below.

Pensions

Pensions have several important benefits. They come with tax relief that can amount to a considerable saving on your tax bill. Capital gains on pensions investments are tax-exempt, and when some pensions mature, 25% can be withdrawn in lump sums, tax-free.

The tax relief on pension payments available to most investors will amount to the value of 100% of their salary up to £60,000. However, this amount tapers off for very high earners who make £240,000 or more in a year, to a minimum of £10,000.

There are several types of pension available:

The state pension is paid to anyone over the pension age who has paid sufficient National Insurance contributions. State pension payments were capped at £203.85 per week or £10,600 per year at the time of writing.
Employers are legally required to enrol any workers who earn at least £10,000 a year in a workplace pension scheme. The employer contributes a minimum of 3% of the employee’s salary, to the employee’s 5% minimum.
Self Invested Personal Pensions (SIPPs) are flexible investment vehicles that allow investors to pick their own portfolio, often from thousands of funds, trusts and individual company shares, while benefiting from tax relief.
Stakeholder pensions are geared toward people who want to build a retirement portfolio without needing to do too much research. They usually have low minimum deposit limits, the fees are capped by law, and they have only a narrow selection of 10-20 funds to choose from.

Pros

Generous tax relief of at least 20%
Higher earners can claim more back on tax returns
Minimum of 3% employer contributions to workplace pensions
SIPPs allow for investment across different asset classes including stocks, trusts, and funds
Government top-ups add 25% to self-invest pensions

Cons

Money is not accessible until you reach 55 years old (57 in 2028)
Withdrawals over 25% of your pension pot are taxed
Very high earners are penalised with reduced tax relief

ISAs

There are several types of ISAs, which are discussed below. All are shielded from capital gains tax, so you won’t need to pay anything if interest payments or profits from an investment are beyond the allowance.

Importantly, unlike in personal pensions, dividends earned in ISAs above the yearly allowance are not taxed.

Adult investors can save a maximum of £20,000 in ISAs per tax year, from 6 April to 5 April the following year. In ‘flexible’ ISAs, this money can be withdrawn and replaced in the same year, though in other ISAs cash that is withdrawn still counts towards the limit.

Historically, you could only save into one ISA of each type per year, but from April 2024 you could sign up to multiple ISAs of the same type each year as long as they remain below the £20,000 limit.

The main types of ISAs are:

Cash ISAs, which earn investors interest on their cash savings.
Stocks & Shares ISAs, which allow investment in company shares, unit trusts, funds, and government or corporate bonds.
Innovative Finance ISAs, which allow for higher-risk investments in peer-to-peer loans or into businesses by buying their debt.
Lifetime ISAs, in which an investor can save up to £4,000 per year in cash, stocks and shares or a combination of both. The government tops up your payments by 25%, and you can withdraw the investments to buy your first home or when you reach 60 years of age.

Pros

Money is accessible at any time
Your entire ISA is tax-free when withdrawn – not just 25%
Stocks and shares ISAs allow investment in stocks, funds and other assets
Lifetime ISAs benefit from 25% government top-ups
You can pay into multiple ISAs
Cash ISAs earn interest

Cons

No tax relief or government top-ups on any except Lifetime ISAs
Limited to £20,000 savings per year
No employer contributions

Which Investment Vehicle Is Right For You?

Whether it’s best for you to invest in a pension or an ISA is down to your personal situation, and we would never recommend one over the other for all savers.

After all, the choice comes down to your own employment situation, goals, current savings, age, tax band, risk appetite and a number of other factors that only you can define.

The following scenarios illustrate how people in different circumstances might approach their retirement savings:

The Homeowner & Professional

Angie, a 35-year-old recruitment manager at an alcohol producer, already has a mortgage on a house with her husband. She’s chosen to take advantage of the generous workplace pension scheme offered by her employers.

“I elected to pay 6% of my take-home salary, so I earn the highest employer contribution at my company of 14%,” said Angie.

“That means that about £10,000 per year goes into my pension from my salary of around £50,000. Since I’m paying off a mortgage already, I don’t feel the need to save anything else.”

This shows how if you are enrolled in one, a workplace pension is a great vehicle for retirement savings and is often worth paying extra if possible.

This is because you get the double benefit of tax relief and employer contributions, which amounts to a very significant boost to your savings.

A person who earns £40,000 per year will make contributions of at least 5%, or £2000, to their workplace pension, but their employer will also contribute at least 3%, or £1200. They will benefit from 20% tax relief for their £2000 contribution – another £400.

This means that even the minimum workplace pension will boost an employee’s contribution by some 60%, and the figure gets higher if you are in a higher tax band.

Some employers like Angie’s contribute a significant amount more, and it’s difficult to beat these terms, even counting the government’s 25% contribution to a lifetime ISA.

The Self-Employed Saver

Martin, 34, is a self-employed creative and stay-at-home dad. Martin spent 10+ years saving for the flat he lives in with his family and wasn’t able to start planning for retirement until last year, when he opened a stakeholder personal pension.

“If I wasn’t a freelancer, I would have got a decent workplace pension going by now, but all my money went to the flat deposit,” he said.

“I only started my pension about a year ago. I get paid by the project, not regularly, so I just pay in what I can afford when I can.

“I don’t know much about the investments – I’m not into finance and with the kids I don’t have time to learn. I used to put my money in a cash ISA, but the interest it brought in was pitiful and it didn’t have any tax benefits. So I chose the pension that seemed easiest to understand.”

Stakeholder pensions don’t have the employer contributions of workplace pensions and they have far fewer investment choices than SIPPs, but in cases like Martin’s the appeal lies in the simplicity.

It’s important to start saving for your pension as soon as possible, and if you don’t have the time to learn about investing, stakeholder pensions offer a simple way to benefit from the tax relief and grow your savings.

The Business Owner

Fifty-year-old publishing business owner Rob isn’t looking to retire anytime soon, but he has been building a SIPP for when he does.

“There’s no question for me that a SIPP is the best way to go. I own my business, so the workplace scheme doesn’t make as much sense, but I get huge tax benefits from the SIPP.

“On top of that, it gives me the scope to invest in just about anything I want to. I invest mostly in tracker funds with a view to the long term, but I also keep a bit in cash to put into stocks if I see a good opportunity.

The SIPP offers a fantastic way for investors to grow their retirement pot proactively by picking their own investments.

It’s an excellent option for anyone with a good knowledge of financial markets to increase their wealth – though as with any trades, this carries risk and your investments could decrease in value.

The High Earner

Forty-eight-year-old Jane worked in banking before going freelance as a financial consultant. She spends a considerable amount of time watching financial markets and her knowledge has helped her invest for retirement.

“I built up a decent amount in workplace pensions which I transferred into a SIPP, and I do still contribute a good amount to that each year for the tax benefits,” she said.

“But actually, I also max out my stocks and shares ISA each year because I find that works out well for me.”

“The money in my ISA is available to take out anytime, so if I see a good investment opportunity like a buy-to-let – or if I actually just decide to retire early, which with any luck I’d like to do – I won’t miss out.”

“But also because when I do retire, my dream is to get a home abroad somewhere. If I kept all the money in the SIPP I would have to pay a lot of tax if I decided to withdraw more than 25%. Since I’ve made a decent amount of money on the ISA, that would be a lot of tax to pay.”

The stocks and shares ISA doesn’t have the same tax benefits as pensions, but it does have one big advantage: flexibility.

With a stocks and shares ISA, your money is available to you at any time. If you need to access it, this will have no impact on your tax bill, will not incur any penalties, and unlike a SIPP, the money is not tied up until a specific age.

The Late-Career Investor

Simon, 63, is an office manager who is getting ready for retirement. As well as his workplace pension, he has built up a SIPP over 20 years and has recently started saving into a cash ISA.

“The workplace pension didn’t give me any control over my investments, so I opened a SIPP. That’s had its ups and downs, but overall it’s done really well,” said Simon.

“The thing is though that when I retire I want to be sure that I’ll have some money saved up to do something nice with, whether that’s travelling or organising family trips. I don’t want that to be at the mercy of stock markets, and I don’t want to have to run down my pension pot too much, so I’m saving it in cash.”

A cash ISA isn’t the best vehicle to save for your retirement since the only benefit it offers is tax-free interest. However, it can be a good supplement to savers who have already built up a pension or other investments and who want ready cash when they retire.

The Early Career University Graduate

Twenty-six-year-old Nathan has been working in his current junior consultancy role for the past three years since graduating. He has an eye on the future, but the thought of retirement seems very far off right now when his most immediate concern is paying off student loans and getting on the property ladder.

“I’m on the workplace pension but I only pay the minimum,” he said. “The rest goes in my Lifetime ISA. I’ve got it mostly in cash and in a few stocks.

“Once I can afford a deposit for a flat, I can stop throwing my money away renting. Then I can think about putting more away for the pension.”

For many, saving to buy a home is a key first step toward financial security, and homeowners will continue to reap the rewards after they have retired.

Since it brings in a hefty government contribution and allows for flexible saving of cash and shares, the Lifetime ISA is especially attractive for people like Nathan who want to start paying off a mortgage and gain equity instead of paying rent.

Bottom Line

The different pensions and ISAs mean that you can choose a setup that addresses your specific needs and puts you in the best position for retirement.

For most people, that will mean paying the maximum possible into a workplace pension scheme or a SIPP.

However, the ISA’s flexibility makes it an excellent option for investors who want to build up cash savings or a stock portfolio in addition to their pension pot, or for those angling for early retirement.

The Lifetime ISA also plays a key role in achieving lifelong security by getting investors on the property ladder.

So, for many people, it won’t be a question of choosing either a pension or an ISA, but of how to combine the two vehicles to achieve their retirement dreams.

Our analysis shows that Interactive Investor offers a compelling package for individuals interested in ISAs or SIPPs, with a first-rate platform, FCA regulation, transparent fees and a straightforward joining process.

Visit Interactive Investor

Article Sources

Gov.uk – Personal Pensions

Gov.uk – Workplace Pensions

Gov.uk – Planning your Retirement Income

Gov.uk – Individual Savings Accounts

Unbiased – Tapered Pension Allowance

Interactive Investor – ISAs

Interactive Investor – SIPPs